Three years after the Miller Shaw report – what has happened?

Three years after an independent commission assessed Cayman’s fiscal situation and the various options available to government to improve the financial and economic health of the Cayman Islands, very few of its recommendations have been implemented.

In the aftermath of the financial crisis the UK Foreign and Commonwealth office concluded that the Cayman government was on a fiscal path that was no longer sustainable. In order to secure the ability to raise more debt, the Cayman Islands government agreed with the foreign office to appoint an independent commission, whose members James C. Miller III and David Shaw submitted their findings on 26 February, 2010.

Their study concluded that the fiscal performance had deteriorated only “recently”, after the growth in spending outran growth in revenues and that the main obstacle to restoring government’s fiscal financial balance were among others the “crippling”, “excessive” and “unsustainable” personnel costs.

With regard to new revenue measures the report found that additional levies would be counterproductive and recommended not to impose direct taxation. Instead Miller and Shaw stated it should be possible to restore fiscal sustainability by undertaking major cuts in spending, by privatising enterprises and by selling other assets.

The study also highlighted the reliance of the economy on financial services and tourism and concluded that significant opportunities exist for government to enable the private sector to supply needed investments in the islands’ infrastructure and broaden the economy’s base.

At the same time the government could improve its efficiency and effectiveness in a number of ways, including completing audited financials and reforming the budget process to both make it more transparent and make officials more accountable, Miller and Shaw concluded.

Three years later the Cayman Islands government has partially implemented only few of the recommendations, not started on others and acted contrary to some.

Do not impose direct taxation

The first of the 12 recommendations of the Miller Shaw report was that the Cayman Islands government not impose direct taxation, mainly because it would limit the performance of the economy and secondly because the authors found excessive spending, not a lack of revenue, to be the problem.

Going through various forms of direct taxation the study noted that for income tax purposes Cayman’s tax base, especially the over 20,000 guest workers was too mobile, and it would be difficult to collect the anticipated revenue.

With regard to a payroll tax the reported stated: “Cayman employers already regard [work permit fees] as high relative to those in other jurisdictions. A payroll tax in addition to work permit fees would add to employment costs and make the Caymans less competitive in the market for skilled professionals.”

The Cayman Islands government has since not introduced direct taxation but only because the proposal to introduce a payroll tax for expatriate workers was withdrawn at the last minute and replaced by another round of work permit and other fee increases.

Cut operating expenses

The commission found that the fiscal problem in the Cayman Islands was too much spending, not too little revenue. “The government‘s fiscal shortfall exists because spending has grown even faster than revenue,” the report stated. It tracked how core government operating expenses increased from $335 million during the 2004/05 financial year to $537 million in the 2008/09 financial year. The report noted, “if the public sector had grown at the same rate as the overall economy, the Cayman Islands would be enjoying a budget operating surplus today.”

The recommended reduction of government’s operating expenditure was only initially successful. When the Miller Shaw report was produced, operating expenses had been reduced from $537.4 million at the end of the 2008/09 budget year to $517.1 million a year later. This was further reduced to $512.4 million in 2010/11 only to surge again by $40 million to $554.4 last year. Current projections point to another increase of operating expenditure this year (to $567.2 million).

Government personnel costs were identified by the study as the main culprit for excessive expenditure. Between 2005/06 and 2008/09 salaries and wages for civil servants had jumped by 46.3 per cent from $172.4 million to $252.3 million. In the following two years personnel costs decreased to $228.1 and $214.7 million. But last year core government personnel expenditure crept up again to $223.1 million and this year it is expected to get close to the peak of 2008/09.

Another reason for the rise in personnel costs was that between 2005 and 2007 the number of civil servants increased by over 500 from 3,332 to 3,843. Since the Miller Shaw report this number has been reduced by 200. The government has committed to further cuts of 10 per cent of staff over the next five years but insists that these reductions would have to come from natural attrition of staff retiring.

Support payments by government to statutory authorities and government entities are another factor in the escalating government expenditure. Outputs for statutory authorities and government entities had increased by 63.8 per cent from $62.9 million to $103 million between 2005 and 2008. Since then initial reductions in expenditure have disappeared and projections indicate a further rise to 108.5 million this year. Despite staff cuts at individual statutory authorities and government entities, staff numbers overall are slightly higher now than they were in 2008 and projected to continue to rise.

Rather than cut staff, efforts were made by government to reduce cost elsewhere in the civil service. As a result the most significant cuts to expenditure have been made to supplies and consumables. From the peak in 2008/09 spending on supplies was reduced by 25.6 per cent or $35.3 million the following year. Since then it has grown again to $100 million but it remains well below the $119.3 million maximum of 2008/09.

Maintain revenue

Based on its belief that the fiscal problem of the Cayman Islands was too much spending, not too little revenue, the Commission recommended the government find ways of raising the same amount of revenue with fewer adverse effects to the economy.

Government did not follow the direction of the Miller Commission and increased fees across the board but particularly for the financial services and tourism industries. As feared by the authors not all fee increases have however translated into higher revenue.

Between the budget years 2008/09 and 2011/12 collected import duties dropped 16.6 per cent when the impact of the financial crisis and a declining population were reflected by less consumption and imports. The property market was equally affected by the crisis and showed less activity in terms of property sales. As a result government revenues from land transfer stamp duty fell by 17.8 per cent.

Revenue from tourism also dropped as far as cruise ship departure taxes are concerned.

However payments of tourist accommodation charges increased by 20.3 per cent. Despite a smaller population than in 2008/09 higher gasoline and diesel duty proved to be a valuable source of growing government revenue, up 50.8 per cent or more than $11.6 million. Work permits and fees on permanent residents saw the biggest increase at more than $13 million.

But not all parts of the financial services sector would bring in more revenue for government simply because of higher fees. Income from bank and trust licences for instance dropped by 1 per cent.

Lower work permit fees

In keeping with its supply-side economic leanings, the Miller Shaw report recommended that rather than generate revenue from higher work permit fees, fees should be reduced and the guest worker programme should be made more flexible to encourage a greater number of work permits and higher government revenues.

Government acted against this advice and raised work permit fees across the board. The number of work permits holders dropped from a high of over 26,000 before the financial crisis to 18,828 in March 2011 before rebounding to 20,823 at the end of 2012.

Despite the decline in work permit numbers, revenue from work permits rose 26.1 per cent between 2008/09 and 2011/12. Fee revenue from permanent residents jumped 75.3 per cent both as a result of higher fees and a larger number of permanent residents. A review of the term limit and the immigration regime has been conducted but government has not acted on the recommendations of the Immigration Review Team yet.

Privatisation and other asset sales

To raise revenue and eliminate a potential drag on government’s resources, the Miller Shaw report suggested the privatisation of government entities and the sale of assets that do not constitute core areas of government responsibility. So far, the Cayman Islands has not privatised any government entities nor sold any assets. While there has been talk, for example, of privatising the sewage system or a sale and leaseback of the government administration building, nothing has taken shape.

Public private partnerships

Given that the government is in no position to borrow for infrastructure developments, larger projects can only be funded by public private partnerships. The recommendation to attract private capital to solve various infrastructure challenges has been discussed in the context of the construction of a cruise ship berthing facility. Yet the implementation has been marred by intransparent processes, which led the UK to create a framework for fiscal responsibility which, among other requirements, prescribes that for any project over $5 million, government will retain independent accounting, legal, financial, economic, environmental and other technical advice to ensure robust appraisals and “value for money”.

Transparency

The framework that was passed into law in 2012, as an amendment to the Public Finance Management Law, sets guidelines for government spending and borrowing, bidding for public projects and rules for financial reporting. As such it tightens prior fiscal constraints and is more comprehensive than the previous fiscal regime, rating agency Moody’s said in its latest assessment of the Cayman Islands. It will therefore contribute to improve the transparency and increase the accountability of those involved in the budget process, as recommended by the Miller Shaw report.

The difficulties with the audit of government entities, however, persist. Although government ministries and statutory authorities have started to submit their accounts on time, the office of the auditor general still laments that some of the information submitted is not usable and unfit for a proper audit.

Develop and maintain a separate contingency fund

The Cayman Islands government has not introduced a contingency fund, in part, because debt increases have to be brought under control first.

Eliminate the tax on funds exported from the Islands

When the Miller Shaw report was produced, government had implemented a levy on remittances. Miller and Shaw were concerned that such a fee would be seen as a dangerous precedent for the taxation of other types of fund transfers, which in turn would damage the Cayman Islands’ reputation as an efficient offshore financial centre. Their report demanded the remittance tax, which largely hits low income foreign workers, should be withdrawn “to lessen the inequity and to quell rumours that the Caymans may well tax other types of fund transfers”.

However, the 2 per cent fee charged on all remittances leaving the Cayman Islands through money transfer entities remained in force was expected to raise $4.6 million per year. In the 2009/10 budget year government collected only $1.5 million.